LLP vs. LLC (Which is better?)
Selecting the appropriate legal entity is a crucial step when launching a business. In the United States, limited liability partnerships (LLPs) and limited liability companies (LLCs) are two popular options that provide owners with limited liability protection.
There are significant distinctions between these two structures that can affect a business’s operations and tax treatment. We will examine the similarities and differences between LLC vs LLP, allowing entrepreneurs to choose the structure that best suits their needs.
The distinction between an LLP and an LLC can be confusing for some, but we’ve done our best to lay out all the differences here. You will ultimately need to understand the intricacies before choosing how to move forward, but if you’re pressed for time (what business owner isn’t?), here are our quick two cents.
LLPs are usually the better choice for a business that operates as a partnership and needs flexibility in ownership arrangements; it is typically the best structure for professional services, like law firms or accounting businesses. If your business isn’t in this category, an LLC is likely the best option, as it offers asset protection and tax benefits.
LLP vs. LLC
LLPs and LLCs share many characteristics, especially when it comes to their financial and legal structure. Both are a way to combine elements of a corporation and a partnership in the most advantageous way for all parties, but they are structured very differently. It is also common for each state’s law to differ, so always check with your Secretary of State’s office.
An LLP, or limited liability partnership, is a kind of general partnership that is formed by at least two owners or partners. About 40 states allow for this business entity to be formed, and it is most common among professional businesses, like law firms or medical practices, that have a significant level of personal liability involved. Not every state allows for an LLP to be formed, and some will have limitations on what type of business can form an LLP.
The key feature of an LLP is the segregation of professional liability among the partners. If one person is found to be negligent in their practice and held liable as a professional, the other partner is protected from any liability themselves. Each partner’s exposure to liability is limited to their own investment in the company, which is a key difference.
An LLP is required to have at least two partners and responsibilities are fleshed out in a partnership agreement. The partners can choose to have an equal say in the decision-making process for the company, or one can be designated as a managing partner with more responsibility while the other is a silent partner.
Best for: Any business with two or more owners can form an LLP, but it is usually preferred for professional service industries. When there is a need for more personal liability protection and segregation of liability, an LLP is a good choice.
Advantages of an LLP
- Asset protection: Each partner’s assets are protected from business debts and obligations, including those that the other partner may cause or contribute to.
- Flexible management structure: Partners can choose to have an equal say in decision-making or designate a managing partner.
- Taxation: LLPs are eligible status as pass-through entities, which allows each partner to claim business profits and losses on their personal tax returns.
- Ease of setup: The process to form an LLP varies by state, but is generally just a matter of filing paperwork, with much less needed than for a corporation.
Disadvantages of an LLP
- Limited protection: The asset protection of an LLP does not cover every scenario. If a partner or employee is found guilty of negligence, malpractice, or wrongful acts, there could be risks that the partnership takes on. Loans or leases that a partner personally undertakes could also be held against the business.
- Varying laws: Not every state allows for LLPs, and each has different laws about the setup. Some industries may be forbidden from forming an LLP, and they may not always cross state laws.
- Tax complexity: Because of varying laws, an LLP that operates in multiple states may have a very complex tax filing process.
- Partnership relations: If business partners disagree on management, profit distribution, or other business concerns it could cause a tense environment.
A limited liability company, most commonly called an LLC, is a popular business structure for small businesses of all kinds. The structure allows a business to operate as a separate legal entity, which offers personal asset protection for its owner or owners, without being taxed as a separate entity. LLCs allow for the benefits of both a general partnership and of a corporation, making them a great option for many entrepreneurs.
The owners of an LLC are considered members, and there can be multiple in a multi-member LLC or just one in a single-member LLC. The management structure and rights of members are typically spelled out in an LLC operating agreement, which will also determine if it is manager-managed or member-managed.
LLCs are available in all states, though the exact regulations may differ. Most states prohibit banking, insurance, and other industries from forming an LLC, and some allow the business formation of a Professional LLC for additional protection against malpractice claims. The Secretary of State typically oversees this process, so you can check with your local office for the exact rules.
Best for: Most businesses can benefit from using an LLC structure, but it is a favorite among smaller businesses and startups that need some level of asset protection. If there is only one owner, you will want to choose an LLC over any kind of partnership.
Advantages of an LLC
- Saves time and money: Compared to something like a corporation, an LLC is much easier to set up. Typically you only need to file Articles of Organization and provide a registered agent, and then keep up with annual reports. This also is less costly than businesses with more record-keeping requirements and associated filing fees.
- Avoids double taxation: An LLC allows for owners to claim all income and expenses on their personal taxes, rather than paying a corporate tax rate. This is known as pass-through taxation and is a huge reason people choose LLCs.
- Fewer requirements: While only 40 or so states allow LLPs, an LLC can be formed in any state. This means it is more likely to be recognized across states and is simpler to maintain. Some professions may need to form a PLLC or other business instead, but this is rare.
Disadvantages of an LLC
- Some personal liability: LLC owners will remain fully liable for their own negligence, misconduct, or other wrongful actions and could have their personal assets at risk.
- Additional taxes: While LLCs do not pay corporate taxes, owners are considered self-employed and will need to pay self-employment taxes to cover their own costs like Medicare and Social Security.
- Business lifespan: In an LLC, the existence of the business is tied to the owners who formed the company. If one dies or leaves, the business needs to be restructured or reformed in their absence.
LLP and LLC – Final word
When you are choosing between an LLP or LLC, it is likely that you can make the decision based on two criteria. If you have only one owner, an LLC is the right choice for you. With two or more owners, your industry may dictate whether an LLP makes sense, as professional services usually benefit more. Otherwise, the two offer similar protections and personal income tax benefits.
It is also important to consider your state’s laws and the laws anywhere you may operate. Be sure to understand if LLPs are allowed and in what contexts before you commit.
Whether you choose an LLP or LLC, you will be able to enjoy the benefits of both a partnership and a corporation to run your business smoothly and effectively for a long time.
Are there rules about what business can be an LLP?
The rules surrounding LLPs vary widely by state, and about 10 states do not even recognize LLPs or allow them to be formed. However, when an LLP is available, it does require at least 2 partners to form. There may also be rules around what industries can and cannot form an LLP, so check with your Secretary of State to confirm.
Is an LLP the same as a PLLC?
No, these are two different structures. A PLLC is a kind of LLC for specific professional services, like medical practices and accounting firms, which may be exposed to a significant risk of certain claims. An LLP is a partnership that provides limited liability to the owners. Like LLPs and LLCs, the two do share a similar structure for tax purposes.
Can an LLC be converted to an LLP?
If you want to bring on partners or move toward an LLP, first check your state laws surrounding the existence of LLPs. You will most likely need to formally dissolve your LLC and then create a partnership agreement, which you can use to form the LLP. You may also need to notify the IRS.
How is a sole proprietorship different?
If you’re looking to start a side hustle, something small that doesn’t need its own business name, a sole proprietorship is best for this kind of new business.